COLUMBIA BANKING SYSTEM, INC. quarterly report, Q2 FY2015

Columbia Banking System, Inc. — 2015 Q2 Form 10-Q Summary

Business Context and Reporting Period

Unaudited quarterly report for the three and six months ended June 30, 2015. Columbia Banking System operates primarily through Columbia State Bank, a full-service commercial bank serving Washington, Oregon and Idaho. Results include Intermountain Community Bancorp for the full six-month period in 2015, while the comparable 2014 period did not include that acquisition.

Key Financial Metrics

Metric	Three Months Ended June 30, 2015	Six Months Ended June 30, 2015
Revenue: net interest income plus noninterest income	$102.5 million	$205.6 million
Net interest income	$81.0 million	$161.4 million
Net income	$21.9 million	$46.3 million
Diluted EPS	$0.38	$0.80
Net interest margin, tax equivalent	4.41%	4.40%
Operating net interest margin, tax equivalent	4.17%	4.18%
Provision for loan losses	$2.2 million	$3.4 million
Noninterest expense	$68.5 million	$135.2 million
Net cash provided by operating activities	Not separately reported for the quarter	$64.6 million

Second-quarter revenue increased 14% year over year; six-month revenue increased from $177.7 million to $205.6 million.
Second-quarter net income increased from $21.2 million to $21.9 million, while diluted EPS declined from $0.40 to $0.38 because of higher shares outstanding following the acquisition.
Six-month net income increased from $41.1 million to $46.3 million. The effective tax rate was approximately 31% versus 30% in the prior-year period.
Net interest margin declined from 4.86% in both comparable prior-year periods to 4.41% for the quarter and 4.40% year to date. Management attributed the decline primarily to lower accretion income on acquired loan portfolios.
Incremental accretion income fell to $7.3 million in the quarter and $14.8 million year to date, compared with $11.3 million and $23.6 million, respectively, in 2014.
Total assets were $8.52 billion at June 30, 2015, compared with $8.58 billion at December 31, 2014. Net loans increased to $5.61 billion before the allowance, up $166.5 million from year-end.
Deposits increased to $7.04 billion from $6.92 billion. Noninterest-bearing deposits rose to $3.21 billion, while interest-bearing deposits declined to $3.84 billion, partly reflecting product migration.
Federal Home Loan Bank advances declined to $45.5 million from $216.6 million. Repurchase agreements totaled $92.2 million. The company had $177.7 million of cash and cash equivalents at quarter-end.
Shareholders’ equity was $1.24 billion, or approximately 15% of total assets. The company and Columbia Bank were classified as well-capitalized, with company CET1, total risk-based capital and leverage ratios of 12.36%, 13.43% and 10.28%, respectively.

Material Changes Versus Prior Comparable Period

Net interest income increased 8% in both the quarter and six-month period, driven by Intermountain-related balances and organic loan growth, partially offset by lower asset yields and lower acquired-loan accretion.
Noninterest income increased 47% in the quarter and 54% year to date. Service charges, merchant fees, bank-owned life insurance income and other income increased, while the expense associated with the FDIC loss-sharing asset declined materially.
Noninterest expense increased 19% in the quarter and 17% year to date. Compensation and employee benefits rose 24% in both periods, reflecting growth and integration activity.
Intermountain acquisition-related expenses were $5.6 million in the quarter and $8.5 million year to date. These costs contributed significantly to the increase in operating expenses.
The allowance for loan and lease losses was $69.3 million, or 1.23% of loans, compared with 1.28% at year-end 2014 and 1.47% at June 30, 2014.
Nonaccrual loans declined to $25.7 million from $31.4 million at year-end. Total nonperforming assets declined to $46.4 million from $53.6 million, and nonperforming assets as a percentage of total assets declined to 0.54% from 0.62%.
Available-for-sale securities declined to $1.91 billion from $2.10 billion. The portfolio had a $7.0 million net unrealized gain at quarter-end, compared with $11.2 million at year-end.
Other comprehensive income was a loss of $11.5 million in the second quarter, primarily from unrealized losses on available-for-sale securities; six-month other comprehensive income was a loss of $2.8 million.

Cash Flow, Liquidity and Debt

Six-month operating cash flow was $64.6 million. Investing activities provided $34.6 million, primarily because securities maturities, repayments and sales exceeded purchases and net loan funding.
Financing activities used $109.7 million, primarily from repayment of $1.49 billion of FHLB advances, partly offset by $1.32 billion of new FHLB advances and a $119.7 million increase in deposits.
Cash and cash equivalents decreased by $10.5 million during the first six months, from $188.2 million to $177.7 million.
At June 30, 2015, the company had $1.69 billion of commitments to extend credit, compared with $1.62 billion at year-end.
Core deposits represented approximately 95.7% of deposits. CDARS and brokered money market deposits totaled $111.4 million, or approximately 2% of total deposits.

Guidance, Outlook, Risks and Unusual Items

The filing does not provide formal earnings or revenue guidance. Management states that it expects continued emphasis on commercial lending and relationship banking, while relying on deposits, FHLB advances, Federal Reserve borrowings and repurchase agreements to support funding needs.

The Intermountain acquisition expanded the company into Idaho and added approximately $964.4 million of assets, $502.6 million of loans and $736.8 million of deposits. Integration expenses and ongoing operating costs remain material.
FDIC loss-sharing agreements continued to affect earnings but are winding down. The FDIC loss-sharing asset was $9.3 million at June 30, 2015, and the estimated clawback liability was $4.2 million. The two largest non-single-family loss-sharing arrangements expired in the first quarter of 2015.
Management identified the allowance for loan losses, business combinations, purchased credit-impaired loans, the FDIC loss-sharing asset and goodwill recoverability as critical accounting areas.
Credit risk remains concentrated in Washington, Oregon and Idaho and in commercial business and commercial real estate lending. The filing notes that economic weakness, declining collateral values or higher delinquencies could increase provisions and losses.
Interest-rate changes could reduce net interest income, particularly given the decline in reported margins and the sensitivity of securities, loans and deposits to market rates. Management reported no material change in interest-rate risk from December 31, 2014.
Other risks include acquisition integration, competition, regulatory and compliance changes, goodwill impairment, liquidity, cybersecurity, operational disruptions and reputational damage.
On August 6, 2015, the company filed a shelf registration statement for potential future debt or equity offerings and other securities. The filing does not specify that an offering was imminent.
Routine litigation is pending, but management does not expect the liabilities to have a material adverse effect. Management reported effective disclosure controls and no material change in internal control over financial reporting.

Investor Verification Checklist

Verify the sustainability of loan growth and whether lower acquired-loan accretion will continue to pressure net interest margin.
Assess the recurring earnings impact of the Intermountain acquisition after excluding $8.5 million of year-to-date acquisition-related costs.
Review commercial real estate concentrations, nonaccrual trends, classified loans and the adequacy of the $69.3 million allowance.
Monitor the remaining FDIC loss-sharing asset, covered assets, expiration dates and potential $4.2 million clawback liability.
Evaluate deposit mix changes, reliance on FHLB and repurchase funding, and the company’s $1.69 billion of unfunded credit commitments.
Confirm capital ratios and dividend capacity under Basel III requirements and applicable regulatory restrictions.
Determine whether the potential shelf offering could affect leverage, funding costs or future share count.